To ordinary investors, it might seem like almost every investment fund under the sun is focused on high-quality companies and stocks. A long track record of superior returns, check. Deep moats and competitive advantages, check. A sustainable and long-run growth path ahead, check. High returns on investment, above average margins, pricing power, etc.

When you talk to as many fund managers as we do at Shares, a far more nuanced story emerges. There are funds whose focus lies elsewhere, sturdy income providers, low valuation opportunities, or stocks in a rut with scope for recovery, or unproven small companies.

The reality for all, is that from the vast pool of stocks on global markets (estimated at around 50,000), a small percentage of these are worth the bother, so developing a useful criterion to narrow down the research universe fast is invaluable. Designing a bespoke way of doing so can really make a fund stand out from the crowd, if the method works.  

UNIQUE MODEL

This is one way the Nutshell Growth Fund (BLP46L6) believes it offers retail investors something unique in the high-quality, large cap stocks space. If the name rings a bell, it’s probably because of the City stir kicked up in late 2023 when Nutshell’s chair, billionaire City grandee Michael Spencer, challenged formidable money man and Fundsmith Equity (B41YBW7) founder Terry Smith to a £10,000 bet that his fund would beat Smith’s during 2024.

Spencer won the bet, Nutshell’s 2024 total return (capital plus income) of 26.4% easily trumping Fundsmith Equity’s 8.9%. In retrospect, it was a safe bet, with Nutshell beating Fundsmith in all of the three full years since it was launched, barring 2022’s down year for both (see table).

So far this year, Nutshell is outperforming Fundsmith again, although neither should be judged on six months’ worth of data.  

Nutshell was launched in May 2020, the brainchild of Mark Ellis, who runs the £112.4 million fund. Ellis draws on what he says was a ‘different path’ into equity fund management. He started investing as a kid during the privatisation years of Thatcher, and the ‘tell Sid’ campaign.

‘I subscribed to various penny share magazines,’ he says, laying the foundations for his finance master’s degree. ‘My dissertation was based on FTSE 350 momentum’.

Ellis’ City career took in bond and property market analysis, and derivatives trading, and it was during this time that the early embers of an investment strategy idea flared. He spent three years modelling his blueprint that identifies over 30 different factors (currently 37, having recently added director deals and AI criteria) that affect outcomes in a portfolio.

There are quality, valuation, growth and technical factors, he explains, such as ROIC (return on invested capital), sustainability of operating margins, FCF yield (free cash flow), PE (price to earnings) and PEG (price to earnings growth) ratios, historical and future growth metrics, plus earnings patterns through different economic cycles, studying share price charts and daily price action analysis. Potential red flags (litigation, antitrust risks, for example) are also included. The number of stocks is reduced to a portfolio of 26 to 33 stocks. 

Ellis and the Nutshell team start with a long list of stocks, perhaps 10,000, and quickly narrows it down to around 600. These are then filtered through his bespoke quant-based model, with each stock given a score from one to 100, producing a concentrated portfolio of around 25 to 35 stocks.

This process is run twice a month, which means rather than simply buying and holding, Nutshell will actively trade portfolio stakes over the short-term. It’s not a case of buying Alphabet (GOOG:NASDAQ), then selling the entire stake, but rather trimming or adding to holdings over the short-term to boost returns.

CHASING ‘EXTRAPOLATED RETURNS’

The fund’s active share is about 90% (currently 87.1%), says Ellis, and we typically make 10 to 15 trades a day to achieve ‘extrapolated alpha’, he says, estimating that its highly active approach adds 5% a year to returns.

Ellis uses Microsoft (MSFT:NASDAQ) as a recent example. Ellis believed the market had been too harsh on the stock ahead of its most recent earnings (30 April), so started beefing up Nutshell’s existing stake. The stock had fallen from $447 in late January to $359 into the last week of April.

As it turned out, Microsoft’s third-quarter results topped the high end of the firm’s guidance with revenues up 13% year-on-year to $70.1 billion, while operating margins of 45.7% also beat 44.6% guidance. The stock jumped nearly 8% in response and has rallied more than 21% since then.

For Ellis, this is about getting high-quality stocks exposure at a reasonable price. The overall PE of the portfolio is 27.4-times earnings, according to the May factsheet, versus 22.4 for the MSCI World Index, which you might expect from its high-quality focus.

Free cash flow yield stands at 3.9% versus 3.5%, while net fund profit margins are 29.4% versus 9.9% (MSCI World). Return on equity is 45.4% versus 14.6%.

In Ellis’ words, Nutshell is ‘more like a hedge fund at a retail price’. Ongoing charges are 0.95%.

When Ellis launched the fund five years ago, he had several quality equity growth funds in mind to emulate or outmatch, such as Fundsmith Equity, Lindsell Train Global Equity (BP2P6W1), and Blue Whale Growth (BD6PG78).

These would be Nutshell Growth’s peer group, but with it offering its own twist. So far so good.

DISCLAIMER: The author of this article (Steven Frazer) has a personal interest in Fundsmith Equity and Blue Whale Growth.

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